Bank says it's sound after fraud scheme

Baltimore County Savings reports $6.9 million loss

July 01, 2006|By LAURA SMITHERMAN | LAURA SMITHERMAN,SUN REPORTER

Officials of Baltimore County Savings Bank, reeling from a check-kiting scheme that cost it the equivalent of seven years' worth of profits, said yesterday that the bank is "perfectly sound" and will aggressively pursue legal action to recover the money.

The $6.9 million loss is another blow to the community bank, which has been operating under federal supervision since December. To forestall enforcement action by its regulators, the bank agreed to shore up its internal controls, its process for identifying customers at high risk of unlawful activity and other procedures.

But David Meadows, general counsel at the bank's parent company, BCSB Bankcorp Inc., said the problems identified in the agreement are unrelated to the check-kiting scheme, which the bank disclosed late Thursday.

"We're still looking at all the issues, and we're going to take all the action we can," Meadows said. "The bank is perfectly sound and well-capitalized. Unfortunately, this is a loss we'll have to deal with."

The FBI's Baltimore field office has opened an investigation into the allegations, spokeswoman Michelle Crnkovich confirmed yesterday.

Check kiting essentially involves drawing money from one bank account that doesn't have sufficient funds to cover a check. Perpetrators typically write a check on one account to deposit in a second account, then return to the first bank with a check from the second bank to deposit, before the first check has cleared. Banking experts said an operation by petty criminals might last a few days before they are detected but that larger customers could tie up financial systems for months.

Meadows said a long-standing commercial customer carried out the scheme, though he declined to name it. He said that as part of the customer's cash-intensive business, it moved "a lot of money" between banks, possibly diverting money illegally for a number of years. The fraud was detected when the customer declared bankruptcy last week, Meadows said.

The incident contributes to what banking experts say is a growing amount of attempted fraud on the nation's banking industry, especially on the centuries-old checking system that still relies on paper documents. While banks are working to implement check verification that uses computer scanning, it won't be fully up and running for two more years.

Tracking fraud can be a daunting task. Banks process more than 35 billion checks each year, with a total value of almost $40 trillion. While consumers increasingly use debit and credit cards for transactions, checks still make up about 10 percent of all consumer payments.

Baltimore County Savings has 18 branches in the Baltimore metro area, stretching from Harford County to Howard County. The bank was founded in 1955, and BCSB Bankcorp became a publicly traded holding company in 1998.

The loss from fraud represents less than 1 percent of the company's assets but will force it to take a $6.9 million charge in the fiscal quarter that ended yesterday. That amount exceeds the bank's profits between 1999 and 2005. It reported net income of $114,000 in the last quarter, or 2 cents per share, and about $600,000 for the last fiscal year. The bank's earnings have declined in each of the past three years.

Meadows said the bank might be able to recover some of its losses from insurance policies and through the bankruptcy proceeding, though that could take "some time."

Attempted check fraud at the nation's banks rose to $5.5 billion in 2003 from $4.3 billion two years earlier, according to the most recent survey by the American Bankers Association. At the same time, the trade group said, actual dollar losses fell slightly to $677 million, from $698 million in 2001.

"Checking schemes continue to be problematic for our industry because fraud artists are constantly trying to find new ways to steal money," said John Hall, a spokesman for the group. "But banks are also coming up with new ways to protect your money, including software and employee training programs."

Banks are required by law to make funds available from most checks within two to five business days, and often funds are made available even though an account has insufficient funds. Congress enacted a law in 2004 that allows banks to exchange check images electronically, rather than physically transporting paper checks. The new system, which Hall said is expected to be in place in 2008, will help banks cut down on frauds like kiting because the checks would be processed more rapidly.

Many banks employ the so-called positive pay system in which commercial customers submit check numbers and amounts to a bank so that when checks are processed, forgeries are more easily spotted.

Larger banks are also beginning to use a program similar to the neural networks employed by credit card companies, in which the habits of a checking customer are tracked and unusual activity is flagged, alerting the bank to possible fraud.

Avivah Litan, an expert on financial industry security with Gartner Inc., said thieves are migrating from credit card accounts to checking accounts, which are considered to have weaker controls.